The IMO Marine Environment Protection Committee (MEPC) held its 74th session in May 2019 with key environmental topics on its agenda including its strategy on reduction of GHG emissions from ships. This was the last MEPC meeting by the IMO ahead of the new sulphur spec implementation on January 1, 2020. With less than six months left to go before implementation, we pause to assess the current state of readiness of the global refining and shipping industries in meeting compliance levels of 0.5 wt% sulphur in the bunker fuel market.
Before taking a survey of where things stand, we briefly look back at key milestones along the way over the past three years that have set the stage for the January 2020 implementation.
- October 2016 – The MEPC announced at its 70th session that it had agreed to implement the 0.5% sulphur limit for marine fuels in 2020. The deliberations at MEPC 70 recognized the various implementation challenges, including fuel availability, blending, stability, compatibility and safety issues.
- February 2018 – The subcommittee on Pollution Prevention and Response (PPR) met and worked through the approach to implementation of the global sulphur cap. A key development from this meeting was a proposal for the implementation of the carriage ban of HSFO.
- April 2018 – At the MEPC 72nd meeting, the IMO announced that the carriage ban proposal had been approved.
- October 2018 – The adoption of the carriage ban was announced at the MEPC 73rd meeting with enforcement set to begin in March 2020.
- May 2019 – The MEPC 74th session saw the approval for adoption at the next session in April 2020, amendments to MARPOL Annex VI to strengthen the Energy Efficiency Design Index(EEDI) phase 3 requirements. A key development from this session was moving up the effective date from 2025 to 2022 by which new ships built needed to be more energy efficient from the baseline established. Another was the resolution to encourage voluntary cooperation between the port and shipping sectors to contribute to reducing GHG emissions from ships.
What Will Compliance Look Like?
The MEPC 74 adopted guidelines for consistent implementation of the sulphur spec rules but it remains to be seen how these guidelines would be implemented especially in the area of fuel compliance. The committee has setup guidelines covering possible actions to be taken when a ship is found to have on board non-compliant fuel either as a consequence of compliant fuel not being available when the ship bunkered or from testing indicating that the fuel on board is non-compliant. Much of this still remains with the global vessel fleet with one of the key issues for vessels being the compatibility of the various compliant fuels. While progress has been made, some issues remain around fuel oil system modifications and tank cleaning, and segregation capability of fuel oil.
Another area of compliance worry is the enforcement of the carriage ban beginning in March 2020. This means that port states will now be able to prosecute vessels that are suspected of using HSFO in international waters, rather than just reporting their concerns to the respective flag state. Vessels could be liable to fines and prosecution and could be forced to debunker the non-compliant fuel by port state control. However, there are still concerns among some developing nations that the carriage ban should not be put in place until there is more certainty regarding the availability of compliant fuels. This is not supported by a majority of member states and the focus is now on undertaking more work in relation to fuel oil quality and the reporting of non-availability of compliant fuels.
We still expect widespread compliance in 2020 with highest rates of compliance achieved in Europe and North America where enforcement is much higher in ports where ECAs are already established. Compliance will be variable across the globe due to regional shortages of compliant fuels in developing economies, such as in Latin America, South East Asia and the Middle East. However, a range of factors will influence the degree of compliance such as lack of availability of compliant fuels in some regional markets and the scale of penalties for non-compliance. Other issues that could impact compliance are the likelihood of exemptions for retrofitting scrubbers and the role that bunker suppliers will play in the enforcement regime. By 2025, we expect effectively full compliance as sufficient compliant fuels become available in all ports globally including in Latin America, South East Asia and the Middle East. Port state control inspections are also expected to become well established at all bunkering ports and a system of fines and threat of criminal prosecution is consistently implemented by all port and flag states.
The Current State of Scrubbers
Major announcements have been made by a range of shipping companies over the past several months on their plans for scrubber installations. Hyundai Merchant Marine has announced it will install scrubbers on 20 new-build mega container ships, while Trafigura will opt for scrubbers on up to 32 of its new build crude and product tankers. Maersk, Spliethoff, Frontline, DHT and Star Bulk have also recently made announcements on retrofitting scrubbers to a number of vessels in their fleet.
From our market intelligence gathering, we expect 580-770 MBPD of high sulfur bunker-consuming ships to have scrubbers installed by January 2020, mostly concentrated towards larger ships (ULCC, VLCC) in the global vessel fleet. The majority of new-build VLCCs are now getting installed with scrubber systems, while the proportion is lower for most other vessel types. Cruise ships have been an early adopter of scrubbers, while containers are key to the ramp up in scrubbed HSFO. Scrubber systems are getting bigger, rising from a maximum of 30 MW systems to over 70 MW and supporting the ramp up of scrubber installations for large container vessels.
While open loop systems tend to dominate, orders for “hybrid ready” systems are growing more popular, which enables a closed loop system to be installed at a later date, dependent on future restrictions on scrubbers operating in open loop modes. Key bunkering hubs (Singapore, Antwerp and Fujairah) have now banned open loop scrubbers as well as other ports in India, China, Europe and the U.S. China has also restricted the use of open loop systems in coastal waters with high levels of marine pollution. The European Union Water Framework Directive will also restrict the use of open loop scrubbers if water quality starts to fall below agreed levels. Alternatively, vessels can switch to low sulphur fuels in restricted areas, while there is also an increasing focus on cold ironing – providing shore side electricity so vessels do not need to use their engines for power generation.
We expect the volumes of scrubbed HSFO to continue rising after 2020 implementation with most of the scrubbed HSFO consumed outside Europe and North America. Given Asia represents about 40% of the global marine fuel market with Singapore accounting for more than half of this share, we believe a majority of scrubbed HSFO will be bunkered in Asia. This implies that Asian shippers will be key to determining the penetration of scrubbers in the global marine fuel market.
Are Refineries Ready?
Refineries stand ready to increase crude throughputs in order to produce sufficient distillate fuel for the bunker market. From our most recent World Refinery Construction Outlook publication, we expect crude capacity growth of 6.7 MBPD between 2019 and 2023 to meet rising global demand. In addition to crude capacity growth, there will also be substantial increases in downstream processing capabilities with global coking and hydrocracking capacity expected to increase by 1.4 MMBPD and 1.5 MMBPD respectively, over the 2019-2023 period.
Deep conversion refineries, particularly the ones in the USGC, stand ready to benefit the most from the January 2020 spec change as the combination of higher distillate product cracks and heavy crude discounts create opportunities to capture higher refining margins. The recent refinery turnaround season has been particularly active as many refineries moved up turnaround plans to position themselves for high utilization rates for the remainder of the year and into 2020. Less complex refineries have been seeking out alternative feedstock sources to reduce their HSFO yields and maximize distillate output. A number or refineries have also been embarking on stream optimization projects aimed at yield shifts from naphtha/gasoline into distillates.
The result of higher global crude runs will be surplus fuel oil production as demand for HSFO continues to decline. We expect this excess fuel oil primarily from Europe/ Russia and Latin America to be consumed primarily in developing countries, along with China, where economic incentives exist for Chinese independent refineries (the so-called teapots) with significant coking capacity. USGC refineries are also expected to absorb additional resid for upgrading, given appropriate price signals and declines in heavy crude supply from Venezuela and Mexico.
As we move through the second half of the year, we expect refined product price dislocations to begin coming into view, notably spreads between distillate and high sulfur fuel oil across late Q3 and early Q4 as we approach the January 1, 2020 implementation date. There will likely be a lot of moving parts as the global shipping and refining industries position themselves for this change with implications for product cracks, refining margins and crude prices riding on it.
Turner, Mason & Company, continues to monitor developments in the global shipping & refining industries. Our latest views are being incorporated in our Crude & Refined Products Outlook which will be published to clients in August 2019. In next month’s publication, we will provide our latest forecast for crude prices, product cracks and refining margins across all major refining hubs globally. If you would like more information on this, or for any specific consulting engagements with which we may be able to assist, please go to our website or give us a call at 214-754-0898.